The High Price of Rapid Tax Refunds

February 18, 2010

The Chicago Tribune recently profiled a Naperville, IL couple struggling, like so many others across the country, to make ends meet. She had to stop working as a nursing assistant because of health problems, and his $8.50-an-hour job isn’t enough to pay all their bills. They’ve fallen behind on rent, even after pawning belongings to help catch up. The article concludes: “Their last hope is that their W-2s arrive soon so they can get an advance on income tax returns and pay off the balance.”

This couple is not alone in considering an “advance” on their tax refund to help them get through tough times. Last year an estimated 8.4 million taxpayers purchased Refund Anticipation Loans (RAL). And as people continue to grapple with the effects of the Great Recession, we may see an even greater number turning to “rapid refund” loans this year to get their refunds faster.

It’s not surprising that lower-income filers are much more likely to purchase RALs than other taxpayers. In 2007 almost two-thirds of all RAL requests came from Earned Income Tax Credit (EITC) recipients--a refundable tax credit targeted to people who work but earn low incomes. Every dollar counts for these families, but in trying to get their money as soon as possible, they end up missing out on the full value of their refund. Taxpayers often end up paying hefty fees and interest to get their money just one to two weeks sooner than they could get it directly from the IRS. The interest rates on RALs run anywhere from 50 to 500 percent. To put that into real terms for those 8.4 million taxpayers: They lost an estimated $800 million of their refunds to RAL fees and interest.

Not only do lower-income taxpayers miss out on these refund dollars, but their communities do, too. A recent study finds that for every federal EITC dollar received in Michigan (an epicenter of the Great Recession), $1.67 in new earnings is generated. The economic impact per resident is even larger in some parts of the state. In Detroit, for example, 39 percent of taxpayers received the EITC in 2007 (compared to 15 percent statewide) for a total of $257 million. That’s a much-needed boost to the incomes of these workers, their families, and the city itself, particularly as Detroit continues to struggle with increasing poverty and working poverty. But the full benefit of the credit isn’t making it to the people who need it most. EITC recipients in Detroit are much more likely to request a RAL (40 percent did in 2007) than EITC filers in other parts of the state (where 25 percent did). Even a conservative assumption that the average RAL costs $65 (based on research from the National Consumer Law Center) implies that the product diverted $2.7 million from the city’s low-income taxpayers in 2007.

Waiting a week or two for a full refund may not be an option for some hard-pressed families. But for those who can, it will mean more money to pay the bills. That extra money can make a difference, not just to people working to make ends meet but also to communities struggling through difficult economic times.